TORONTO BECKONS

With retail overload in the domestic market and fierce competition for high quality sites, U.S. retailers and developers increasingly are looking international for growth opportunities. Their first stop is usually not the Far East, Europe or even Mexico. It's Canada.

With a healthy economy and many cultural similarities, Canada is the natural choice for retailers and developers looking to expand. Only 80 miles north of Buffalo, New York, is Toronto, the engine of the Canadian economy.

The greater Toronto area has 20 percent of Canada's wealth and about a sixth of its population. It is the financial and business center of Canada with about 14 percent of the country's retail sales.

Toronto is also economically the strongest city in Canada with a growth rate of 5.3 percent in 2004.

The city is the gateway into Canada for U.S. retailers. “Every major U.S. chain that is in Canada started by coming into Toronto,” says Peter Woolford, vice president of policy development and research at the Retail Council of Canada.

Unlike the U.S., Canada is not over-retailed. According to an International Council of Shopping Center report, Canada has 14 square feet of retail space per person, while the U.S. has 21 square feet. “Competition isn't as great and therefore sales are higher,” says Tom Burns, senior vice president at JJ Barnicke Ltd., the nation's largest commercial real estate brokerage.

In fact, sales can be 10 percent to 40 percent higher in Canada, says Wendy Evans, president of retail services company Evans and Company Consulting.

High Barriers to Entry

One reason why Toronto is not over-saturated is the high barriers to entry. Its progressive political environment can create a less-than-friendly business climate. Recently, Sam Zell, founder of Equity Office Properties, the world's largest office REIT, said he would never do business in Canada due to the nation's onerous taxes. While Canadian companies do not have to pay for employee healthcare, thanks to socialized medicine, business taxes can be 5 percent higher than in the States.

In Toronto, real estates taxes can average about C$20 a square foot (about US$16.41), says Tom Johnson, president of Thomas Johnson Realty Ltd.

The Canadian labor force also tends to be more unionized than in the U.S., and labor laws makes it more difficult to fire an employee.

Canadian laws on development also are restrictive, especially if a zoning change is required. “It could take years to get zoning changed, because the public process could frustrate the whole thing and it could be very costly for the request change,” says Burns. “It's a cumbersome process that you might not win.”

Many communities have zoning regulations placing large retail centers in designated areas; much like the United States. It is difficult, however, to get land-use codes changed to build outside designated zones. For example, the public-input part of the process can be very lengthy.

“It can be done, but it's not for the faint of heart,” says John Morrison, senior vice president of the Oxford Retail Group.

In addition, U.S. retailers also have to deal with potentially expensive distribution logistics. Canada is slightly larger than the U.S. in terms of land, but only has one-tenth the population. This leads to high distribution costs.

For example, if a company imports apparel goods into the states under U.S. quota, it can't export those goods to Canada. Therefore, a company such as Gap Inc. has to import its jeans directly to Canada. Apparel items usually have to be shipped into Vancouver, which is 2,700 miles west of Toronto. Due to the distance and lack of major city centers, the cost of distribution is often too high for retailers.

For those retailers who do venture into Canada, however, the success rate is high; about 95 percent survive, says Evans.

“You have to come in through acquisition or partnering,” he says. Wal-Mart Stores Inc. bought its way into the market in 1994 when it purchased 122 Woolco stores from Woolworth's.

Mills Makes its Move

Recently, The Mills Corp. entered into Toronto by partnering with Ivanhoe Cambridge, a Canadian retail development company that is owned by a private pension fund. The two companies built the 1.2 million-square-foot Vaughan Mills about 12 miles northwest of Toronto. Vaughan Mills opened in early November.

The mall introduces such new U.S. retailers to the Canadian market as Lucky Strike Lanes, Burlington Coat Factory and a 140,000-square-foot Bass Pro Shop, which should be a hit with the country's many outdoor enthusiasts.

CANADA RETAIL SALES YEAR-TO-DATE (THROUGH 9/04)*

Selected Categories

2004

2003

Change

Drug Stores

$13.47

$12.48

7.90%

Department Stores

11.76

11.07

6.20%

Other Gen. Merchandise

11.62

11.01

9.50%

Furniture

7.45

6.81

9.50%

Electronics

6.08

5.90

3.00%

Apparel

11.01

10.61

3.70%

Sporting Goods, Hobby, Music and Book

4.85

4.75

2.20%

Home Improvement

12.62

11.48

9.90%

*Figures are in billions of U.S. dollars.

Source: J.C. Williams Group

“Vaughan Mills is the best of big boxes and unique retailers such as Bass Pro,” says Steve Jacobsen, Mills Corp. executive vice president. “There is also a good mix of American and Canadian retailers. I look at Vaughan Mills as a collection of the best retailers of North America.”

Vaughan Mills is the first enclosed mall built in Canada in 14 years, proving how difficult it is to build large-scale shopping centers here.

Vaughan Mills is also unusual because it is one of the few Canadian malls that is owned, at least partially, by a publicly traded REIT. Most malls in Canada tend to be owned by private pensions funds.

One of Canada's largest pension funds, the Ontario Municipal Employees Retirement System (OMERS) with 350,000 members, co-owns with an unnamed institutional investor three of Toronto's largest malls: the 1.6 million-square-foot Square One Shopping Centre, the 1.4 million-square-foot Yorkdale Shopping Centre and the 1.7 million-square-foot Scarborough Town Centre. Yorkdale has the highest sales productivity of any enclosed mall in Canada at $900 dollars a square foot (US$738).

Pension funds started buying malls during the recession of the early 1990s when public real estate companies came under financial pressure, said Morrison of Oxford Retail Group, which is the retail division of OMERS.

The only significant retail REIT in Canada is RioCan, which owns most of the country's power centers. Big box U.S. retailers, such as Home Depot and Costco, usually tenant these centers, located in the periphery of the greater metropolitan areas.

However, due to severe winters, enclosed malls tend to be the preference of most Canadian shoppers. “A climate-controlled enclosed shopping center with over 250 stores and underground parking is much more compelling to a shopper than an outdoor power center where you have to literally drive from store to store,” says Morrison.

While enclosed malls remain retail hot spots, Toronto also has an active downtown core. “Our cities are more dense than in the U.S.,” says Brent Houlden, consumer business practice leader for Deloitte Consulting in Canada. “Toronto is a very centric city where we have a downtown center which is very much alive.”

Offices and condos are sprouting up along Lake Ontario and Yonge Street, the city's main drag. Retailers are following. Recently, Swedish clothier H&M opened a 28,000-square-foot store on Yonge Street at Toronto Eaton Centre, one of Canada's largest malls and tourist attractions. Located at the intersection of Yonge and Dundas streets, the area is a retail mecca in the city with rents around $100 (about US$82).

Other international retailers such as Zara and The Body Shop also have opened up in Toronto's downtown.

H&M also opened a 13,000-square-foot store in midtown Toronto on Bloor Street, often referred to as the city's “Fifth Avenue.” On Bloor Street, rents can go well beyond the city average of C$50 (US$41.01) per square foot to almost C$200 (US$164).

Apple Crosses the Border

About 180 U.S. retailers operate in Canada; most of whom started in Toronto. Recently, Apple Corp. said it would enter Canada with two stores in the Toronto area by mid-2005.

While most are successful, some U.S. retailers do falter; especially those who don't do their homework. “Some have come into the market and stumbled and learned the expensive way how to do business,” says Evans. “There are different holidays, different customs, different cultures.”

The Sports Authority Inc., for example, did not do well in Toronto, partly because it did not cater to the more European tastes of its customers, says Evans. “Toronto is more European in its taste and buying habits,” says Evans. “There is a French influence in both food and fashion. Some of their active wear was too basic, not fashion forward enough.”

U.S. retailers that do succeed in Canada, such as Gap have put local management in place to keep an ear to the ground, says Evans.

“Few U.S. retailers who have entered here and have failed,” says Houlden.